FX: Pakistan’s climb to the emerging-markets club

Pakistan’s economic reform programme is starting to bear fruit, but a huge appreciation in the real exchange rate during the past two years is hurting the country’s export market, warns the IMF, amid expectations the country will soon join the MSCI emerging markets (EMs) index.

Since 2013, the country has worked with the IMF to stabilize
its economy, making "significant progress" in strengthening
macroeconomic stability by reducing the budget deficit and
rebuilding foreign-exchange reserves, according to the latest
review published earlier this year.

"Fiscal consolidation has been at the heart of the
programme. The authorities have made significant progress
… bringing the fiscal deficit (excluding grants) down
from 8.5% of GDP in FY 2012/13 to 5.4% in FY 2014/15," it
states.

They aim to reduce it further to 3.5% in 2016/2017, to
shrink public debt.

Charles Robertson, global chief economist at investment bank
Renaissance Capital, says: "Everyone
knows about India with [prime minister
Narendra Modi] trying to reform. Exactly the same is
happening in Pakistan, I would argue even more rapidly."

Ashraf Mahmood
Wathra, State Bank
of Pakistan

Meanwhile, the current-account deficit is broadly stable
– the IMF predicts it will remain at about 1% this
year thanks to a reduced oil import bill. It was more than $1.6
billion in the nine months from July 2015 to March 2016
– a year-on-year reduction of 18.5% –
according to figures released in April from the State Bank of
Pakistan.

Stumbling blocks

However, economic progress is stymied by a number of
factors, including security concerns, power outages, lower
cotton prices and significant real exchange-rate appreciation
during the past two years of 17%, warns the IMF.

The rupee is free floating, but the central bank intervenes
to keep volatility down. Otherwise, the currency would likely
be even stronger, says economist Alan Cameron at boutique
investment bank Exotix.

"[There are] pretty good investment inflows, so there is
upward pressure on the currency," he says. "The central bank is
leaning on that by buying dollars in the spot market. If the
central bank stepped out, the currency would be appreciating
right now."

Pakistani authorities plan to further bolster FX reserves,
including by continuing with the central bank’s
spot purchases and taking advantage of the oil windfall, notes
the IMF.

Further accumulation could also help arrest further
appreciation of the real effective exchange rate, which has
been affecting competitiveness, says the policy lender in its
report.

There is discussion as to whether the currency should be
devalued to help the country’s beleaguered cotton
exporters, who have to contend with power shortages and poor
infrastructure, but experts do not foresee any meaningful
devaluation.

The exchange rate has remained broadly stable since the end
of December, with USD/PKR trading at 104.

Brian Muggeridge Andersen, portfolio manager at Danish asset
management company BankInvest, predicts a maximum 3% to 5%
currency devaluation over the course of the year.

Future investment

BankInvest’s frontier market fund has assets
under management of approximately $170 million, of which almost
18% is invested in Pakistan.

"Our view on Pakistan’s economy and as a whole
is that there is a lot more promise and potential that it is
given credit for," says Muggeridge Andersen.

"The country is currently undergoing a reform process that
is allowing businesses to invest and develop much better than
was the case five years ago. Many companies have a solid, clean
balance sheet."

Hasan Jafri,
HJ Advisory

The country is on the brink of being upgraded from a
frontier market to an
EM by indexer MSCI, which will announce its decision in
June. An upgrade, in addition to billion-dollar infrastructure
investment from China, will attract greater interest from a
wider range of investors, predict frontier experts.

Large-scale manufacturing related to the CPEC will nudge GDP
growth to 4.5% for the full year 2015/16, predicts the IMF,
despite a weak cotton harvest and decline in exports.

However, more needs to be done, such as removing
institutional and structural bottlenecks, says Hasan Jafri,
founder and managing director of Singapore-based investment and
country assessment advisory firm HJ Advisory.

"Over the longer term, Pakistan needs to focus on improving
education, collecting equitable revenue, and creating a safe
and stable environment to attract the kinds of investment flows
a country its size and demographic profile requires," he
says.

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